The High - Risk Prepaid Tuition Plan

Last month, as the fall semester got underway at the state's 10 universities, some 7,450 candidates for the freshmen class already had prepaid their four-year tuitions. In 1998, another 9,360 will have prepaid tuition - and the numbers will continue to rise in fall semesters to come: Parents and grandparents have prepaid tuition for more than 285,000 Florida children, some of them still in diapers.

The vehicle that has created the opportunity for payment in advance is the nine-year-old Florida Prepaid Tuition Program, and by some measures it has been extremely successful. Cheered on and zealously guarded by its founder and chairman, Stanley Tate, the program has sold between 34,000 and 58,000 prepaid contracts a year, including contracts for dormitory rooms. And Tate and the program's administrators have been good stewards of the parents' money: With more than $1.8 billion in assets, mostly committed to future tuition payments, Florida Prepaid is the envy of more than a dozen other states with smaller programs.

In a different state, the success might be unqualified. But in the financial context of Florida's higher education system, the prepaid program is helping to lock the state's colleges and universities in a lethal spiral toward third-rate status.

The real problem is Florida's sorry recent history of underfunding higher education: As enrollment surged from 87,393 students in 1986 to 126,002 the past academic year, state funding per student has plummeted from a high of $7,156 per full-time student in the 1989-1990 academic year to $5,676 last year, according to a report entitled "Florida's Ten Year Summary of Appropriations and Governor's Appropriation Ledgers." That includes lottery dollars.

Viewed as a percentage of total state general revenue, higher education received 8.5% last year, down from 11% in 1985. And the Legislature isn't likely to loosen up, according to Sen. John Grant (R-Tampa), current head of the education committee. "There's not going to be any significant increase from general revenue funds," he predicts.

As lawmakers have choked off general appropriations to higher education, they've also chosen not to ask the users of the university system, the students, to make up the difference. Last year, Florida's $1,888 average annual tuition ranked 49th in the country, behind only Idaho. The national average college tuition was $3,358, nearly twice Florida's, according to an annual survey by the state of Washington. To University System Chancellor Charles Reed, it's a lethal combination. "Florida has the worst of both worlds,'' he sighs. "Low tuition and low state support."

In this mix of underfunding and low tuition, the prepaid program has become a proverbial 600-lb. gorilla; its very size makes it difficult to change and hard to get around. Boosting Florida's tuition up even close to the national average, for example, would threaten the prepaid program's financial stability and create headaches for administrators and politicians that both are eager to avoid. The program showed its clout last December when a Board of Regents panel recommended upping tuition by 10% for 10 years. Lawmakers, well aware of the prepaid plan's big constituency, rejected the idea and held the increase to just 7.01% for 1996, with a 7.8% increase for this academic year. This year, the Regents showed signs of throwing in the towel on tuition, recommending only a 6.6% tuition hike for the 1998-1999 school year. "We're recognizing what we're going to get out of the Legislature," says Board of Regents spokesman Alan Stonecipher.

That kind of increase isn't enough, say Reed and some business groups, to maintain the quality of Florida's higher education system. Worse, they say, it also shows that lawmakers are making tuition decisions based on what's good for the prepaid program instead of what's good for students in state colleges and universities. Too little in tuition charges plus too little in general appropriations equals declining quality - fewer courses, bigger classes, long waits for required courses and cutbacks in books and other resources.

Ultimately, say Reed and the others, failing to invest in the state's higher ed system - by increasing either general funding levels or tuition charges or both - will make suckers of the parents who now find the prepaid program so appealing. They think they've purchased a Chevrolet education for their children, but could find a Yugo waiting for them in a few years when their children enroll.

Sen. Bob Graham, an ardent supporter of the prepaid program, believes in keeping tuition costs low and has lauded the prepaid program on the floor of the U.S. Senate because it furthers that goal. But when asked about the questions raised by business leaders and Chancellor Reed, he concedes that the biggest concern is the impact of the program on the future quality of the universities. Graham, who has purchased five prepaid contracts for his grandchildren, says: "The big risk that I as a grandfather am taking is that in 12 years the university system will have degraded to where my grandchildren say they don't want to go to college there.''

State on the hook

The pressure that the prepaid program exerts on tuition stems both from its size and financial structure.

As they collect money, administrators invest the pool of pre-payments, much like a pension fund, anticipating that earnings will grow fast enough to meet or outpace growth in tuition charges.

The key number is 7.5% - that's what the program figures it needs to earn each year to keep up with inflation and other costs. Since it was founded, the program actually has done much better than that, earning an average return of about 12.6%. There's now $1.6 billion in the pool earmarked for future tuition and an additional $206 million surplus, according the program's 1997 annual report. But the surplus can't go to general university operations and must be retained to make up any shortfall in years when the program's investments return less than the 7.5% goal.

Most of the assets, more than $1.2 billion, are invested in U.S. Treasury obligations and in other federal agencies. Just over $100 million goes into commercial paper, and nearly $100 million to corporate bonds, according to the 1997 annual report. Since the program has enjoyed a healthy surplus, the Legislature, which created the program and must approve any changes in its policies, opened the way for more aggressive investments in stocks in 1994. So, the prepaid plan moved a modest $90 million into well-known equities.

Because the prepaid program board can't expect to continue earning more than 10% indefinitely, they're dead set against sustained tuition increases greater than 7.5%. Anything above that over a period of time, say administrators and actuarial experts, could bankrupt the program. If this happens, the state would be on the hook for the prepaid contracts of all children within five years of college enrollment. More significant than the financial liability it would create for state government, an insolvency would make 285,000 Floridians very unhappy, a virtually unthinkable possibility for the state's politicians.

The problem is that the 7.5% ceiling imposes an unrealistic cap on the state's already constrained higher education budget. Florida's tuition compared to the national average has been declining steadily since the 1980s and needs to go up more than 7.5% a year to maintain the quality of the system. "They've priced a product that they can't change," complains Reed. "The university system needs to set whatever are reasonable tuition rates. The prepaid program shouldn't control what those rates are.''

The recession of the early 1990s, when appropriations by lawmakers declined, offered firsthand illustrations of a weakening university system. Class sizes swelled and fewer classes were offered, forcing students to wait semesters to complete required courses. Faculty salaries were frozen, contributing to a decline that has seen average salaries fall from 13th during the mid 1980s down to 42nd. Library hours and new book acquisitions were cut back. "Our libraries fell behind some of our peers in the Southeast,'' says Board of Regents' Stonecipher.

Tuition increases have remained modest despite pleas from state business leaders and educators. In a 1996 report called "Higher Education in Florida: The Emerging Catastrophe," the Business/Higher Education Partnership noted that Florida is one of only four states "that have both low tuition and low per capita state support.'' The group, which includes the Florida Council of 100, a powerful group of chief executive officers, and the heads of the state universities, community colleges and independent colleges, defines what is at stake: "Florida cannot prosper in the 21st century and be internationally competitive without a stream of well-trained graduates. Florida needs the business and high-paying jobs that spin off from top research universities."

At its winter meeting last year at the Breakers in Palm Beach, the council's higher education committee recommended increasing Florida's tuition toward the national average. At that meeting, Tate, a member of the committee, was the only dissenter, arguing vehemently for holding the line on tuition increases.

Tate makes no bones about preferring quantity over quality: "I'm less interested in having the best universities in the country than having the greatest accessibility." A 69-year-old Miami real estate developer, Tate got involved in education at the urging of Graham when he was governor. "I'm interested in having 75% of high school kids go to college," Tate says.

In a follow-up last February to its 1996 study, the Business/Higher Education Partnership found that the prepaid program could absorb significant tuition increases for a number of years. "We agree with Chancellor Reed that the plan cannot be the arbiter of tuition changes," the report said. "That would be the classic case of tail-wagging-dog." In its 1996 report, the partnership had written that higher tuition would make "future contracts more expensive and could even hurt the plan's actuarial soundness. But that is not a reason for tuition to remain far below true costs.''

The prepaid program also may have another, less obvious but just as insidious effect on higher ed financing, according to Michael A. Olivas, a University of Houston law professor who's writing his second book on state-sponsored prepaid tuition programs. Olivas, who says he generally supports prepaid tuition, argues that the programs can discourage lawmakers from increasing general funding levels. He maintains that lawmakers see only a big pot of money and don't make the distinction that the money is already accounted for - it's a future liability, not a present asset. "The Legislature is going to be looking at Florida Prepaid's pot of money, and there will be real pressure for them to appropriate less because it's considered so well-funded," Olivas predicts.

Back-door fees

With no additional general funding or tuition hikes on the horizon, there will be pressure on state colleges and universities to resort to the back door funding mechanism of fees to meet their costs. Promotional materials for the prepaid program acknowledge that it doesn't cover all fees imposed on students, including so-called "local fees" at various colleges and universities. But the material doesn't explain that such uncovered fees are growing every year at Florida's 10 campuses and constitute an ever-higher percentage of the real cost of college. The upshot: Parents in the prepaid program who think they've paid for everything may find they'll need to go back to the well once their children are ready to enroll.

For example, the Board of Regents is recommending a system-wide "technology fee" of $50 per student, per semester, which wouldn't be covered by the prepaid plan, although the Legislature rejected a similar proposal last semester. But other fees on various campuses, which are not subject to legislative veto, have been rising rapidly. The average local fee, none of which is covered by the prepaid plan, went from $7.69 per credit hour in 1985 to $15.64 last year. They are expected to rise to $26.87 in 2004. These local fees, which cover such services as athletics and healthcare, vary vastly from campus to campus. At Florida A&M and the University of South Florida, for example, local fees approach 27% of tuition. On average, students paid $469 in fees for two semesters.

Choosing mediocrity

Ultimately, many say, the prepaid program offers a lesson in choices. The state has to decide what kind of system it wants and then pay for it. It can, like Virginia, choose high tuition and fees and low public subsidies. Or, like North Carolina, low tuition and high levels of state support. But it cannot, most agree, continue the pattern of low tuition and low state support if it wants to maintain even a decent higher ed system. In the meantime, Florida - which so often seems to choose mediocrity when it comes to schooling its children on all levels - appears on the verge of living up to its reputation once again.

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How The Prepaid Plan Works

The Florida Prepaid Tuition Program, enacted into law in 1987, allows parents to pay in advance for their children's tuition at one of Florida's 10 universities or 28 community colleges. Parents can sign up for a four-year university plan that covers 120 credit hours or for a two-year community college plan covering 60 credit hours. More than 285,548 children have been signed up, locking in tuition charges and certain fees. Fees covered by the program include building, capital improvements and financial aid charges.

Three Ways To Pay. One lump-sum payment; monthly payments of equal amounts until the child enrolls; or a five-year, 55-payment plan. Parents who choose monthly installments pay 7.5% in annual interest on the lump sum amount. Most parents making monthly payments use a coupon book as with a mortgage or car loan. For example, parents who paid this year for four years at a university for a child who will enter college in 2010 could have paid $5,856 in a lump sum, or $57.03 monthly until 2010, or 55 payments of $125.37.

No Guarantee. Enrolling in the prepaid program does not guarantee that a child will be admitted to a Florida university, but prepaid administrators point out that anyone with a high school diploma or the equivalent can enroll in a community college, and that university contracts can be converted to cover community college expenses. If a student opts for an in-state private school, the prepaid program will transfer the average amount of Florida's university tuition. If the student chooses to go to an out-of-state school, the plan will transfer the average Florida tuition or the money paid into the program plus 5% interest, whichever is the lower.

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ACCESSIBILITY

Enough Room?

It's the year 2007. Three high school seniors, all equally qualified, have applied to a state university so crowded that it only has room for one. The family of one can pay cash. The family of another needs a scholarship. The family of the third has already paid up through the Florida Prepaid Tuition Program. Who should get in?

Just as the prepaid program plays a big role in setting tuition rates at state schools, it's also becoming a big part of a coming space crunch at Florida's universities.

Granted, overcrowding will be a problem regardless of prepaid tuition: The Department of Education projects the number of high school grads will grow to 135,000 in 2008 from 89,397 in 1996. Enrollment at Florida's 10 universities in 1996-97 was 126,002, and Board of Regents spokesman Alan Stonecipher questions "whether there will actually be enough space for all the high school students coming into state universities and community colleges" in a few years.

In fact, Florida already has twice as many students in each university and college as the national average, 20,992 vs. 9,268, according to a 1997 National Center for Education Statistics study. Citing its most recent statistics covering 1993, it also found Florida had fewer four-year institutions to serve the population aged 18 to 44 than any other state.

The prepaid program may pose some particularly nasty issues for university administrators. The program is growing so fast that the number of students with prepaid contracts is coming ever closer to the total number of available slots for freshmen in the university system. This year, for example, some 17,000 freshmen will enter Florida's universities. There were about 7,450 eligible students with prepaid contracts, and next year there will be 9,360.

How many youngsters with four-year prepaid contracts actually have been enrolled in Florida's state universities? Program administrators claim they don't have figures after 1993, an amazing assertion. Is it possible that those running the $1.8 billion program don't know how many prepaid kids actually got into state schools?

Meanwhile, if the number of prepaid contracts continues to grow, "there just won't be room for everyone. Unless something dramatic is done in the next 10 years, there will be space for prepaid but there won't be room for anyone else," says John Huffman, research associate with the State Board of Education's Postsecondary Education Planning Commission.

One thing that may happen is that many prepaid students whose parents think that "college is taken care of" will not get into a state university. Prepaying tuition is no guarantee that when students are ready for college, they will be admitted. This is stated in promotional brochures for the prepaid program, but overlooked by some.

Another likelihood is that administrators will have to deal with the uncomfortable question of whether prepaid students should get preference. Stanley Tate, chairman and founder of Florida's prepaid program, and University System Chancellor Charles Reed contend prepaid students will not enjoy an edge, but Michael Olivas, an expert on prepaid programs and a law professor at the University of Houston, disagrees. "Those pressures are going to become completely irresistible," he asserts. "Let's say you're an admissions officer, who are you going to admit? A kid from some barrio who needs a scholarship or one who is fully funded?"

The prepaid board is seeking to address the oversupply of would-be students by broadening its program to include Florida's private schools. But parents who seek to transfer their prepaid savings to a private Florida college will be in for a shock. The $5,856 for four years of tuition at state schools will cover just one year at relatively inexpensive Flagler College, but only a fraction of one year at Stetson University ($15,675) and the University of Miami ($19,512).

If a student opts to go out-of-state, he'll get either the average cost of Florida tuition or the amount paid in plus 5% interest compounded annually, whichever is lower.

The Postsecondary Education Planning Commission is grappling with alternatives to meet the soaring demand. Among proposals being debated:

- Beef up community colleges so better students would find them a viable option for their first two years of study.

- Add new universities like Florida Gulf Coast, which came online this year.

Subsidy for the wealthy

Lost somewhere in the accessibility question are needy students. The prepaid program looks more and more like an education subsidy for the middle class and the wealthy.

In a 1996 survey by the prepaid plan of 208,453 of its participants, nearly 30% of the families who divulged incomes reported making more than $50,000. Another 24% noted they made between $40,000 and $50,000. Meanwhile, only 8,908, or 8%, reported incomes below $20,000. Families were not required to divulge income, and 44% didn't.

An analysis by the American Association of State Colleges and Universities of prepaid plans released in July concluded that the plans don't do much for the needy. "Prepaid tuition plans ease college affordability concerns for participants, primarily middle- and upper-income families," the study reports. "In practice, they are not a means for increasing access to higher education - especially for the neediest students."

And the study doesn't see much hope of change: "Many analysts agree that efforts to increase participation by lower-income families will at best have a marginal impact because many of these families simply do not have the disposable income."

The report labels federal tax breaks for families in plans such as Florida's "a form of subsidy" for people who can afford tuition. Under a federal law passed in August 1996, parents who pay into prepaid plans won't pay taxes annually on the plan's earnings. They're taxed only when money is dispersed to universities, and then only at the student's income level.

This summer, Sen. Bob Graham lobbied to remove all federal taxes for families with prepaid plans, but the measure failed. Parents with prepaid contracts will be able to take advantage of President Clinton's Hope Scholarship Tax Credit, taking a credit of $1,500 for the first two years of college and $1,000 the next two. Those credits are reduced for couples making more than $80,000 annually and single parents making more than $50,000.

Tate says that when the prepaid plan was being drafted, the goal was to help the poor. But he changed the focus when legislative staffers complained that people like themselves with moderate incomes were the ones who needed help. So, he opened the program to students enrolling in four-year universities, and the final legislation dropped income as a factor in enrollment.

To combat criticism that the poor are left out, the prepaid plan's board created a scholarship pool for low-income youths. The scholarship fund has $3 million to dole out to mentoring programs for low-income high school students and college scholarships, Tate says. Law professor Olivas calls the scholarship fund too modest and merely a public relations tool. "It was done largely to supply political capital," he says.

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SAVING FOR COLLEGE

"Not All Things To All People"

Investment advisors continue to shake their heads when asked about the popularity of Florida's prepaid tuition program and its 7.5% return. Parents and grandparents could be earning double that in a mutual fund, they say.

But ask participants in the prepaid plan why they don't simply invest their money privately to get a higher return, and the answers reveal a conception of education savings as somehow distinct from other investments. Some admit they lack the discipline to sock away college money or feel threatened by investing on their own.

Consider Rusty McIntyre, who signed on a year and a half ago for the five-year, $121-a-month plan for her 2-year-old granddaughter Cassidy. McIntyre, 48, a real estate broker and office manager for a Jacksonville dermatologist, says she talked with a financial planner prior to signing up for the state plan, but "I didn't get any satisfaction. It was too involved. I feel more comfortable with this. I was brought up not to speculate too much."

Some parents do figure they can do better saving on their own. Ron Roberts, a project manager with a Jacksonville mechanical contractor, is among the 17% of prepaid plan participants who sign up but later drop out. It cost him. He bought a contract for a son in 1989, but cancelled it two years later. Participants who hold a plan only a short time get back only the amount paid, no interest, and have to pay a $50 cancellation fee.

Since dropping out, Roberts has been investing on his own in stocks and mutual funds. He says he's earning about 12% a year. "If you're willing to do some investing on your own, the state program probably isn't a good idea," Roberts says.

Program founder Stanley Tate gets irritated by comparisons with private investing. "It wasn't written to be a competitor to the stock market. If people are looking for an investment on a capital basis, they shouldn't be investing in this."

The program, says Tate, "is not all things to all people. It's just better than nothing. It's given a large number the opportunity to put money away for college who might not have done so."

The most vocal critic of Florida's plan is Peter Roberts, founder of the New Jersey-based College Savings Bank, which offers high-yield CDs to help parents earn money for higher education. He's competing with the Florida plan and other state-sponsored plans for a share of the hefty tuition savings market, estimated at $3 billion, according to the College Savings Plans Network, a lobbying group for state prepaid plans. Roberts has been involved in intensive legal volleys with Florida's plan. He sued Florida's plan claiming it infringes on his patent for calculating future tuition costs and the investment return necessary to meet them. The case is pending in federal court in New Jersey after a judge denied Florida's attempt to have the lawsuit dropped. Roberts had also sued Florida's plan for false advertising, but that lawsuit was dropped.

Roberts' CollegeSure CDs earned its holders an average of 5.25% interest over the past 10 years, according to the firm's most recent brochure. But those earnings are taxed annually. So, Roberts is also waging a battle against the favorable federal tax status Congress bestowed on state-sponsored plans in August 1996.